China - Reforming social security in a socialist economy

Report No. 8074"HA China Reforming Social Security in a Socialist Economy June 25, 1990 Country Operations Division China Department Asia Regional Office FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS The Chinese currency is called Renminbi (RMB) It is denominated in Yuan (Y). Each Yuan is 1 Yuan - 10 jiao - 100 fen Caleudar 1989 January 1990 US$1.00 = Y 3.72 US$1.00 = Y 4.72 Y 1.00 = US$0.27 Y 1.00 = US$0.21 FISCAL YEAR January - December ABBREVIATIONS AND ACRONYMS ACFTU - All-China Federation of Trade Unions CASS - Chinese Academy of Social Sciences CNCA - China National Committee on Aging CSSC - China Social Security Cost model GDP - Gross Domestic Product MOCA - Ministry of Civil Affairs MOF - Ministry of Finance MOL - Ministry of Labor MOP - Ministry of Personnel OECD - Organization for Economic Cooperation and Development PBC - People's Bank of China PAYG - Pay-As-You-Go PICC - People's Insurance Company of China SAT - State Administration for Taxation SPC - State Planning Commission SRC - System Reform Commission UI - Unemployment Insurance  'ALL . TITLE s China: Reforming Social Security in a Socialist Economy COUNTRY : China REGION : Asia SECTOR : Country Economic REPORT TYPE CLASSIFICATION MM/YY LANGUAGE 8074-CHA ERA Official Use 06/90 English PUBDATE : June 1990 ABSTRACT: The report presents the results of a World Bank study of China's retirement pension programs and unemployment insurance system in the urban formal sector, with the objective of identifying fur- ther improvements in overall social security reform in China. The report presents the rationale for social security reform in the context of a reforming socialist economy. The current oper- ation and practices of China's retirement pension and unemploy- ment insurance systems are described; strengths and problems are discussed: and recommendations for reforming the retirement and unemployment insurance programs, as well as their administra- tion, are presented. Future costs of China's retirement system under current regulations and selected reform recommendations are projected to the year 2040 using an actuarial cost model for China's system developed for this study. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CHINA REFORMING SOCIAL SECURITY IN A SOCIALIST ECONOMY Preface This report presents the results of a World Bank study of retirement pensions and unemployment insurance in China based in part on a mission in MarchlApril 1989 that included discussions with government officials and enterprise visits in Beijing, Shanghai, Changzhou, Guangzhou, Qingdao, and Wuhan. The report was discussed with the government in conjunction with an international symposium on social security organized by the State Commission for Restructuring the Economic System in Beijing in December 1989. The sym- posium included several formal presentations by international experts, fol- lowed by a wide-ranging exchange of ideas on social security issues in China and other countries. The World Bank study team consisted of Anthony Pellechio, task manager and mission leader; Caroline Jen coordinated data collection and statistical analysis and developed the China Social Security Cost Model; Ehtisham Ahmad examined retirement pension policy and international experi- ence; Anthony Atkinson (consultant, London School of Economics) was responsi- ble for unemployment insurance; Lillian Liu (consultant, United States Social Security Administration) was responsible for social security administration; Huang Yasheng (consultant, Harvard University) examined institutional aspects of social security policy and administration. The World Bank study team collaborated with a counterpart team oi Chinese government officials from several agencies. The main study mission w;as hosted jointl; by the Ministry of Finance (MOF) and Ministry of Labor (MOL) under the direction of Mr. Zhu Fulin, Director, General Planning Department, MOF, and Mr. Han Liangcheng, Director, Department of Insurance and Welfare, MOL. The counterpart team was headed by Ms. Lu Heping, Deputy Division Chief, General Planning Department, MOF. The team also consisted of Mr. Qu Zuyin, Mr. Tian Huamin, MOL; Mr. Ni Di, Mr. Zhang Zhongjun, and Ms. He Xiaopei, System Reform Commission; Mr. Yun Zhiping, MOF; Mr. Yuan Yuan, State Administration for Taxatior.; and Mr. Liu Feng, State Planning Commission. The World Bank study team extends its thanks to these and other officials whose work and insights were indispensable in producing this report.  - i - CHINA REFORMIPG SOCIAL SECURITY IN A SOCIALIST ECONOMY Table of Contents Page No. SUMKARY AND CONCLUSIONS ........................................ i The Need for Social Security Reform in China . . . i Characteristics of China's Current System . . . ii Rising Retirement Expenditures ........................ . ii Fragmentation of Retirement Pensions . . . iii Inadequate Financial Policies ......................... . iii The Unemployment Insurance Program ........................ . iv Reforming China"s Retirement Pension Programs .............. iv Toward a Tiered Pension System ... iv Pooling ................................................ v Financing .... v Investment of Pension Reserve Funds . .. vi Administration ... vi Medium-Term Reforms . . . vi Future Policy for Unemployment Insurance . . . vii Conclusion ................................................. vii I. SOCIAL SECURITY AND ECONOMIC REFORM .. 1 Introduction .. ..... . .... ..... 1 A. The Rationale for Social Security Reform in the Context of China's Economic Reforms ... , ... ... . .. ....... . ... . 2 Enterprise Reform ... 2 Employment Policy ........ 3 Tax and Price Reform ...................... . . . .. 5 B. Overview of Social Security and Introduction to Retirement Pension System and Unemployment Insurance Program .......... 6 The Retirement Pension System .......................... 8 Traditional System . ......................... 8 Reformed System ... .. ............. . 9 The Unemployment Insurance Program ..................... 12 C. Conclusion .... . . ........................................... 13 II. RETIREMENT PENSION PROGRAMS ................................. . . . 21 Introduction . . . ...... ........ . 21 A. Retirement Expenditures Increase Relative to Other Labor Insurance Expenditures . . .. .. . . .. 21 Low Retirement Ages and Early Retirement ............... 25  - ii - Page No. B. The Impact of China's Aging Population ..................... 27 C. Fragmentation of Retirement Pension System . . 29 Enterprises Face Uneven Pension Costs .................. 29 Pooling Practices Vary Across Cities . .. 34 Enterprise Taxation is Altered to Negate Pooling ....... 36 Contribution Rates and Bases Vary .. 37 Benefits are Defined Formally and Semiformally .. 39 Lack of Coverage and Portability . . 42 Standards for Funding and Investment are not Defined... 42 D. Administration of Retirement Pension System ................ 43 Brief Historical Background ............................ 43 Transition from Employer-Liability to Social Insurance. 44 Problems in Administration ............................. 48 E. Economic Consequences of China's Retirement Pension System ..................................................... 52 Labor Market Distortions ............................... 52 Older Workers are Encouraged to Retire ............ 52 Enterprises' Demand for Labor is Distorted ........ 52 Labor Mobility is Impaired ........................ 54 Inefficiency from the Lack of a Link between Contri- butions and Benefits ................................... 55 Inequity from the Effect of Inflation on Pension Benefits and Reserve Funds ............................. 55 Pension Benefits .................................. 55 Reserve Funds ............................... .... .. 55 III. UNEMPLOYMENT INSURANCE AND ECONOMIC REFORM IN CHIN A ............ 59 Introduction ........................................... 59 A, The Economic Reform Background to Unemployment Insurance ... 59 Changes in Chinese Labor Market Policy .. 59 Contract Workers . ....................... 60 Dismissal of Workers . . ................................. 61 Bankruptcy and Reorganization of Enterprises .. 61 Other Forms of Employment .............................. 62 Likely Significance of Reforms for Unemployment ........ 62 B. Unemployment Insurance ....... 64 Form of the Legislation . . 64 Operation of Ul in Practice . . 66 Administration of Unemployment Insurance . . 67 C. The Economic Impact of Unemployment Insur ance ............. 69 The Impact in Theory ................ . 69 Effect on Workers ........ .............................. 70 Effect on Enterprises ........ 71  - iili- Page No. IV. REFORMING RETIREMENT PENSION PROGRAMS AND UNEMPLOYMENT INSURANCE ...................................................... 75 Introduction .... 75 A. Short-Term Projections and Reform Recommendations . . 76 Toward a Tiered Pension System ......................... 77 Provide an Adequate Basic Pension Benefit . . 78 Retirement Pensions Should Keep Pace with Inflation .... 79 Combine Pension Pooling for Permanent Employees and Contract Workers ..... .............................. 80 Expand Individual Contribution Base and Require Permanent Employees to Contribute ................. 80 Expand Pension Benefit Base ............................ 81 Levy a Social Security Tax to Provide Adequate Pension Benefit .. ............................. 82 Adjust Revenue Sharing Between Central, Provincial, and Local Governments ............................. 83 Invest Pension Reserves in Special Government Bonds .... 84 Mandate Coverage for all Workers in the Urban Formal Sector .... ................... 86 Maintain Separate Retirement PensiuIL System for Government Sector ........................... .. .. . 87 Reforming China's Social Security Administration ....... 88 B. Medium-Term Projections and Reform Recommendations ......... 89 Adjusting Pension Benefits for Inflation . . 92 Raise Retirement Age ........ . 92 Include More Years of Earnings in Calculating the Pension Benefit Base ............................. 95 Expand Pooling . ....... 96 C. Future Policy for Unemployment Insurance ................... 96 Extension of Coverage .. 96 Benefit Lev,' and Duration ............................ 97 Contribution Rate and Structure ........................ 98 Ul and Employment Services ............................. 99 Unemployment Insurance Fund . . 100  - iv - Page No. TABLES IN TEXT 1.1 Social Security System in China ................................ 15 2.1 Retirement and Medical Components of Labor Insurance and Welfare Benefits for State Units ............................... 22 2.2 Aggregate Cost of Labor Insurance and Welfare Benefits ......... 23 2.3 Number of Retirees, Disabled and Li Xiu Cadres ................. 25 2.4 Projections of China's Elderly Population and the Ratio of Working Age to Elderly .................... . ......... 27 2.5 Dependency Ratios for Enterprises in the World Bank Social Security Study Survey .......................................... 33 2.6 Retirement Pension Pooling in Five Cities: Contribution Base and Rate and Retirement Pension Reserves .................. 39 2.7 Entitlement Criteria and Benefit Levels for Workers in State Enterprises, Governament and Party Organizations ................ 41 2.8 Comparison of Average Pension in State and Collective Units to Average Wage, Urban Income, and Urban Expenditure .............. 56 2.9 Composition of Labor Insurance and Welfare Benefits for State Units .......................................................... 57 3.1 Main Features of Unemployment Insurance Introduced in 1986 ..... 65 4.1 Required Contribution Rates and State Tax Expenditures for Pay- As-You-Go Pension Programs for Permanent Employees and for Both Permanent Employees and Contract Workerss 1992 ................ 77 4.2 Required Contribution Rates and State Tax Expenditures for Pay- As-You-Go Persion Programs for Permanent Employees and for Both Permanent Employees and Contract Workers: 1997 ................ 90 4.3 Contribution Rates Required for Pay-As-You-Go Pension Program for Permanent Employees: 1992-2030 ............................ 91 4.4 Contribution Rates Required for Pay-As-You-Go Pension Program for Permanent Eraployees and Contract Workers: 1992-2030 ....... 91 4.5 Life Expectancy in China ....................................... 94 BOXES IN TEXT 1.1 Social Welfare in China ........................................ 6 4.1 Recent Social Security Reform in Japan .... . 78 4.2 Pay-As-You-Go Funding, Full Funding, and Partial Funding ....... 85 4.3 Special-Issue Bonds for Social Security Fund Investment in the United States ........................................... # ................ 87 CHARTS IN TEXT 1.1 Ministry of Labor ..................... . 19 2.1 The Hierarchy of Labor Administration and Social Security Programs ......... .............................................. 46  Page No. FIGURES IN TEXT 2.1 Pensioners as a Percentage of Working Population and Pension Expenditures as a Percentage of Total Wage Bill................ 30 2.2 Share of Elderly in Population of China, Japan, Federal Republic of Germany, U.K., and U.S............................. 3 2.3 The Ratio of Employees to Retirees in PAYG Program, Single Program for Permanent Employees and Contract Workers, and Program for Government Sector.............. 32 ANNEXES 1. China Social Security Cost (CSSC) Model  - i - CHINA REFORMING SOCIAL SECURITY IN A SOCIALIST ECONOMY Summary and Conclusions i. China's social security system covers a wide range of benefits. For workers in the %rban formal sector, these benefits, including retirement pension, are provided almost entirely by enterprises, which are thus responsible for nearly all their employees' living needs throughout their lifetime. In order to break the direct link between the enterprise and the provision of all retirement income and to share tne costs of retirement programs among enterprises, the central government has recently encouraged local governments to experiment in setting up retirement pension pools.. ii. In addition to enterprise-based retirement and social benefits, the other main factor tying workers to their enterprises is China's system of enterprise-specific job security. In order to shift from this system of job security to one that would provide income security, the government promulgated regulations in July 1986 establishing a 'wait-for-employment3 program, referred to in this report as unemployment insurance. At the same time, a labor contract system, including regulations for dismissing workers by state enterprises, was also introduced. These regulations constitute an integrated package of labor reforms that support enterprises' need for greater autonomy in a more market-oriented environment. Unemployment insurance is a necessary component of labor and enterprise reforms to protect workers who may lose their jobs temporarily. The criteria for eligibility for unemployment insur- ance are closely linked to these reforms. Unemployment insurance pools have been established at the local level and, thus, serve a purpose analogous to retirement pension pools which are intended to alleviate enterprises' direct responsibility for pensions. iii. The government's recognition of the need to maintain workers' welfare in the course of economic reform represents a deepening of its understanding of the arduousness and compl3uity of reform. By providing for the people's well-being during changing economic circumstances, social security reform can enhance public support for the entire economic reform program of the govern- ment. This report examines China's experience with retirement pension pools and unemployment insurance to date in the urban formal sector, with the objective of identifying further improvements in overall social security reform in this sector. The Need for Social Security Reform in China iv. Three developments during the 19808 have given rise to the need to reform China's social security system. First, with greater enterprise auton- omy, the enterprise-based social security system instituted in the early 1950s in the context of an economy managed almost entirely by the State has become increasingly inappropriate. Existing social security provisions have not so far allowed for the needs of individ'ial or nonstate-run enterprises that have sprung up in recent years. Second, tied as it is to the workplace, China's current social security system is a major obstacle to economic efficiency and,  - ii - specifically, to enterprise reform. A key element of enterprise reform is to separate enterprise and government budgets. But strict adherence to financial autonomy makes it difficult for enterprises to continue financing social security benefits that, in principle, workers are meant to receive indepen- dently of the enterprise where a worker is employed; conversely, the payment of social security benefits through grants from the government to enterprises seriously compromises their financial autonomy. Sharing financial responsi- bility for providing labor insurance among enterprises would largely address this dilemma. v. Third, with increasing incomes and the general improvement in living standards, new methods to contain the increasing costs of providing benefits are needed. Otherwise, the present social security systems will simply become a heavy financial burden--a burden that will increase rapidly in the next ten to twerty years as the number of retirees grows and recple enjoy longer lives. vi. Social security reform would facilitate not only enterprise reform, but also other important components of China's economic reform. Tax reform, which aims at achieving uniform treatment of different enterprises, is an important element of China's economic reform program for decentralizing decision-making on production and investment and improving microeconomic effi- ciency. However, the government faces pressures to depart from uniform tax rules--among them the aeed to -ompensate enterprises for their different pen- sion burdens. Standardized tax rules are more easily applied across enter- prises if they are accompanied by uniform pension provisions. vii. Price reform is also impeded by the enterprise-based pension system because controlled prices are often used to subsidize enterprises burdened by disproportionate pension costs. Thus social security reforms that lift full financial responsibility for pensions from enterprises would also facilitate price reform. Characteristics of China's Current System viii. Rising Retirement Expenditures. Retirement expenditures have grown significantly in the last ten years. Overall labor insurance costs nearly doubled, from 13.7% of total wages in 1978 to 27.02 in 1987 (2.2? and 4.62 of GDP respectively). Retirement and disability benefits increased over fourfold from 3.0Z of total wages in 1978 to 12.7Z in 1987 (0.5Z and 2.2Z of GDP respectively). Retirement and disability expenditures increased twice as fast as total labor insurance costs. In 1987, pension benefits for retired employ- ees in state enterprises amounted to 33Z of all labor insurance benefits. Hedical benefits for retired and disabled employees amounted to 5.7Z of total labor insurance benefits and welfare benefits for these employees, 92. ix. The ages at which workers become eligible for full retirement bene- fits in China--60 for men and 55 for women--are low by international stan- dards. Retirement at the minimum age is encouraged both by the method of pension calculation based on a worker's last year's wage, and by the incen- tives enterprises have to retire older workers as a way to reduce surplus labor and minimize contributions to pension pools based on the number of active workers.  - iii - x. Over time, the aging of China's population means that pension expen- ditures as currently structured will increase dramatically from 12.7? of total wages in 1987 to almost 20X by 1997, to 25Z by 2010, and to over 48? by 2030. Projections of subgroups within the population reveal further pressures: because most younger workers entering the formal urban labor market are con- tract workers, the increasing number of retired permanent employees will have to be supported by a declining number of active permanent employees. Conse- quently, the current pension program for permanent employees in enterprises is not sustainable. xi. Fragmentation of Retirement Pensions. Reforms in China's retirement system to date are characterized by a variety of different Nexperiments" gov- erning the retirement programs of different groups of workers and, more impor- tantly, with the different pooling arrangements varying widely across enter- prises. Specifically, the degree of pooling varies because enterprises with low retirement costs are reluctant to join pools with enterprises with high pension burdens. Moreover, current central government regulations establish separate pooling programs for permanent and contract workers, thereby obstructing the sharing of costs between older permanent workers and younger contract workers. Consequently, the benefits of risk pooling are not fully realized. Because of the diverse retirement pension experiments, pooling of resources is not yet wide enough. In addition, program administration and supervision by local social insurance agencies is too limited. xii. China's pension system has several shortcomings. The system is fragmented: contribution rates vary across regions and sectors and apply to different bases. The lack of any financial or actuarial link between contri- butions and benefits causes inefficiencies in the labor market. Early retire- ment, for example, carries no cost in terms of lower pension levels. Enter- prises can minimize contributions on behalf of workers to enhance profits because the government is the final guarantor of pension benefits through subsidies in the form of tax concessions, controlled prices, or direct grants. xiii. Inadequate Financial Policies. Retirement pensions for permanent employees are operated on a pay-as-you-go basis, while pooling for contract workers is funded. Administratively, pension funds are managed by labor insurance companies directly subordinate to city and county labor bureaus. Some prevent the use of contract workers' pension funds to help pay retirement expenses for permanent employees, while others allow them. Pension funds are deposited in local bank accounts that often do not keep pace with inflation. Local interest in keeping financial resources within the locality do not always lead to investments with the highest returns. xiv. Pension pooling has placed enterprise-based programs under the super- vision of city and local governments for the first time. The local labor insurance company is the responsible agency whose immediate concern is to ensure accurate accounting by enterprises of the total wage bill and of retir- ees and benefit payments due. With few exceptions, direct management of pen- sion programs is left to individual enterprises as the labor insurance company does not have the resources for detailed supervision of enterprises. Expanded supervision and audit of eligibility requirements and benefit levels is neces- sary to guard against unnecessary escalation of retirement program costs.  - iv - The Unemployment Insurance Pro8ram Xv. Although unemployment insurance (UI) is a natural complement to the enterprise and labor reform policies being pursued by the Chinese government, it is rare among countries at China's level of development; only one of 32 low-income countries includes unemployment insurance in its social insurance system. The growth of contract work, the dismissal provisions for permanent workers, and the possibility of bankruptcy all mean that unemployment in China can be expected to increase in coming years. Zvi. To date, the number currently receiving unemployment benefits is extremely small. According to the Ministry of Labor, the total number of recipients from 1986 to 1988 was about 100,000. Through the beginning of 1989 in Shanghai, with 2.62 million active workers (of whom 210,000 are contract workers), about 3,000 received unemployment benefits each month, for a duration of about ten months. In Guangdong, where unemployment insurance covers some 2.7 million workers, disbursements were made to 4,000 workers by the beginning of 1989. These numbers appear low in relation to the likely number of unemployed, suggesting that eligibility and/or coverage remain low. xvii. As with the pension system, labor service companies need to improve administration and supervision, for example, in the determination of continu- ing eligibility. Difficulties in fund investment affecting pension funds for contract workers also apply to unemployment insurance funds. Reforming China's Retirement Pension Programs xviii. The objective of pension reform is to provide for individuals' retirement equitably and efficiently and in a way consistent -with China's general reforms, including bureaucratic streamlining, separating regulatory and management functions, and strengthening the government's macroeconomic management capabilities. Reform of retirement pension programs has to be considered in the framework of China's existing institutions and practices for administering these programs. xix. Toward a Tiered Pension System. The report recommends, as an overall structural reform, moving gradually toward a three-tiered pension system covering all workers. The first tier would provide a basic pension to all workers in the urban formal sector, for which an acceptable standard is the pension stipulated in current regulations, that is, 75Z of standard wages, which is equivalent to 401 to 60? of total wages and consistent with replacement rates found internationally. The second tier would consist of enterprise-sponsored pensions above the basic pension closely tied to individual contributions and, consequently, not requiring pooling on a wider scale. The third tier would entail having self-employed workers and individual enterprises obtain coverage through the People's Insurance Company of China or other insurance companies. xx. The first tier would be funded on a pay-as-you-go basis, although partial funding to the extent possible should be considered as a way to pre- pare for the aging of China's population. The exact contribution rate would depend on China's demographic characteristics and the degree of partial fund- ing, if any.  - v - xxi. The report recommends reforms in the operation of China's current retirement pension system that move it towards the sttuctural goal of a tiered pension system. In other words, China can pursue reforms, described below, on an operational level in the short and medium terms, in the framework of overall structural reform. xxii. Pooling. The report recommends combining pension pools for permanent employees and contract workers in state and collective enterprises at the local level because the pay-as-you-go program for permanent employees is not sustainable over time. It would help achieve the important objective of extending pooling and broadening the base of the pension system. These pools would be administered by local governments for the purpose of providing the basic pension and therefore constitute the first tier of the pension system. Ideally, pooling should be combined for all workers in the urban formal sec- tor; however, this may only be feasible in stages over time. xxiii. Financing. An important issue for social security reform in China is the sharing of responsibility for financing retirement pensions among the state, enterprises, and individual employees. Having permanent employees contribute toward their retirement pension would reduce the burden on the government and enterprises and introduce an element of individual responsibil- ity into the retirement pension system. A degree of equity is achieved and the unification of separate pension programs for permanent and contract work- ers is facilitated. xxiv. Requiring permanent employees to make an individual contribution may not be realistic immediately. However, it may be feasible if phased with expansion of the contribution base for contract workers in the short term. The report therefore recommends expanding the base for contract workers' con- tributions from standard wage to standard wage plus allowances; and, requiring permanent employees to contribute 3? of their standard wage plus allowances. The individual contribution rate should be kept low and could be compensated for with a wage increase during the early stages. It may be more realistic to have permanent employees participate in contributory plans for the second tier of pensions rather than for the first tier. xxv. Paralleling the expansion of the contribution base, the pension bene- fit base should be expanded to standard wage plus allowances. This consti- tutes a first step toward linking an individual's benefit more closely wvth contributions and having pension contributions regarded as deferred compensa- tion rather than as a tax. Bringing allowances into the benefit base also shifts these expenses from enterprises to retirement pension pools where they belong, and alleviates the uneven pension burdens on enterprises under current pcoling arrangements. xxvi. The report recommends the introduction of a compulsory social secur- ity tax to provide a stable source of finance for the first tier of the pen- sion system. Although a central social security tax is ultimately desirable in order to achieve the widest possible risk pooling for social insurance, the most feasible course in the short term would be a social security tax on a local or, where possible, wider regional basis. A local social security tax would be the source of revenue for local pools combining permanent employees and contract workers and it would represent a promise to workers of a reliable source of finance for the basic pension. A social security tax is more sup-  - vi - portable by the public if workers understand that it is designated for their retirement pensions and enterprises understand that it relieves them from supporting retired workers fully. xxvii. Before a central social security tax can be implemented, a period of time is needed to allow coordination with tax reform and financial sector reform because of the current fragmented nature of the pension system, uneven pension benefits across enterprises, sectors. and regions, and the complex financial relations among central government, local governments, and enter- prises. Nonetheless, a central social security tax would have a unifying effect on China's fragmented pension system. The implementation of a central social security tax comports with the priority attached to the development of a moder: tax system in China. In this regard, social security reform and tax reform are mutually reinforcing if pursued at the same time. xxviii. Under a tiered pension system enterprises would be responsible for retirement benefits above the basic pension. Thus, expansion of the pension base to standard wage plus allowances divides responsibility for providing pensions between the government (responsible for a basic pension related to standard wage) and enterprises (providing additional pensions based on total wages). xxix. Investment of Pension Reserve Funds. The real value of pension reserve funds should be preserved through prudent investment of resources. The financial sector is not sufficiently developed to provide a safe, adequate yield for investing pension reserves. As noted, local labor insurance compa- nies deposit pension funds in bank accounts that do not keep pace with infla- tion. Thus the most prudent course for investing pension funds would be either investment in government bonds which yield positive real interest rates or bank accounts whose long-term real value is guaranteed. XXX. Administration. Administrative reform of retirement pension programs should focus on two areass improving implementation of retirement pension programs at the enterprise level; and, establishing supervision and inspection at the provincial government level as well as at the city and county govern- ment level. xxxi. Medium-Term Reforms. In order to prepare for the rapid aging of China's population after the year 2010 and contain increasing pension costs, further reform measures are necessary in the medium term, which include: (a) Raising the retirement age gradually over the period 1995-2015, for example, by three months every year so that by 2015 it will be 65 for men and 60 for women. Retirement age could be raised faster if this can be done without encountering significant resistance from workers. (b) Basing the calculation of pension benefits on an average of several years' earnings in an individual's working career. This could be done gradually over the period 1996-2015 in step with raising retire- ment age. (c) When conditions permit, local pension pools should be combined into larger regional pools and eventually provincial pools.  - vii - Future Policy for Unemployment Insurance xxxii. The regulations governing unemployment insurance in China are des- cribed as "interim" and in a number of respects the program has yet to have full effect. Extension of coverage should be considered in several stages. First, there is the extension to cover all workers within state enterprises, including temporary and seasonal workers. A second stage would include work- ers in other types of enterprise, including collective and private enter- prises, joint ventures and foreign-owned businesses. The third, major stage would be to include township and village enterprises employing some 80 million workers. xxxiii. The adequacy of the present benefit formula, linking UI to standard wages, cannot readily be assessed in the absence of evidence about the effec- tive replacement rate secured for recipients. This aspect of the UI program is not in obvious need of adjustment. xxxiv. The 1Z contribution rate may also need to be raised to meet higher anticipated rates of unemployment in the immediate future. The official urban unemployment rate is expected to rise from 2.3Z at the end of 1989 to 4Z or higher in 1990. xxsv. With the aging of the contract labor force, the problem of unemploy- ment among those in their 509 will become much more important. Unless labor service companies are able to provide employment opportunities for older work- ers, there may be a need for extended benefits for them, and this added cost would need to be met from worker contributions. xxxvi. There are several important issues regarding the structure of contri- butions and the way in which UI resources are raised. Consideration should be given to: individual contributions from the insured person as well as from the enterprise; setting the contribution rate at a uniform level for all industries or relating it to the industry's experience with unemployment; financing UI on a national basis or setting the rate to secure balance within provinces; and financing UI separately from other social security programs, or including it in a general social security tax. xxxvii. As with pooled pension funds, there appear to be problems--both cur- rent and potential--with the accumulation of funds. There is no standardized procedure for the collection of contributions and for the accounting for fund management, and there certainly seems to be a case for better supervision and for clarification of the role of different ministries and bureaus. Conclusion xxxviii. A key objective of social security reform is to relieve individual enterprises of full direct responsibility for their workers' retirement pen- sions by establishing funds that pool resource-. and risks among enterprises. By doing so, social security reform would complement and support other eco- nomic reforms. Retirement pension pooling would reduce the financial burdens of old enterprises and protect workers' well-being. Pension pooling that maintained workers' coverage from job to job would facilitate labor mobility.  - viii - An important operational task is to determine the appropriate regional and sectoral coverage of these pools. xxxix. Economic reform in China has reached a point where social security reform is an important step--a step needed to facilitate labor mobility in a changing economy, support progress of China's economic reforms, and promote national economic development and growth.  CHINA REFORMING SOCIAL SECURITY IN A SOCIALIST ECONOMY I. SOCIAL SECURITY AND ECONOMIC REFORM Introduction 1.1 The term "social security" has been recently adopted in China to refer to the broad range of benefits for workers provided by employers and welfare assistance for the general population provided by the state.l/ In the formal sector the more familiar traditional term is "labor insurance" which refers to the "Labor Insurance Regulations of the People's Republic of China, put in effect on March 1, 1951. These regulations, as modified at various times, define benefits for workers in state enterprises and big collectives.2/ This report examines two important components of labor insurance in the urban formal sector--retirement pensions and unemployment insurance. These two programs are critical elements in China's economic reforms and face serious problems in their finances, structure, and administration. This report iden- tifies these problems, analyzes the effect of future demographic and economic developments on the finances of the programs, and recommends reforms. 1.2 A fundamental objective of the urban reforms initiated in 1984 was to make enterprises responsible for their own profits and losses as a crucial component of the transition to a more market oriented economy. This has sig- nificant implications for the benefits of enterprise workers. Under estab- lished arrangements, enterprises provide a range of benefits, including retirement pensions, to their workers. In a more competitive environment in which enterprises are responsible for their own financial viability and cannot depend on state subsidies, enterprises will not have the ability to employ workers as needed, including dismissing them, if each enterprise continued to be individually responsible for directly providing labor insurance benefits to workers. Recognizing this, the central government encouraged local govern- ments in 1986 to experiment with pooling of finances among enterprises to share the cost of providing retirement pensions and relieve each enterprise from having direct financial responsibility for its retired workers. 1.3 In 1982, as part of urban economic reform, the government encouraged employment of workers under contract for a specified period, usually one to five years, in contrast with the traditional system of lifetime permanent employment. In 1986 central government regulations required that all new workers be hired under the labor contract system and ended permanent employ- ment of new recruits in state enterprises. The labor contract system was designed in part to give enterprises the ability to employ workers in a more 1/ Wang Di, "Social Security and Restructure Options of China," State Planning Commission, undated draft, p. 3. 21 "Big collectives" are designated not according to size, but to the level at which they are administered. When a collective operates under authority at the county or city level or above, it is designated "big".  - 2 - market oriented economy. Contracts are subject to renewal which allows enter- prises to change their work force in response to demand for their production. The 1986 regulations introduced a wait-for-employment program, or what is referred to here as unemployment insurance, as a natural complement to the labor contract system. This program is designed to provide income to workers whose employment contracts are not renewed or whose enterprises are bankrupt or near bankruptcy due to reorganization or who are otherwise dismissed from their jobs. These grounds for eligibility are closely linked to labor market and enterprise reform. Just as retirement pension pooling experiments were intended to free enterprises from direct responsibility for providing pensions to their own retired workers, so too were unemployment insurance pools estab- lished at the local level to break enterprises' direct responsibility for providing Income to workers whether they are working or not. 1.4 This chapter presents the rationale for social security reform in the context of other reforms of China's economic system in Section A. Section B gives a brief overview of China's social security system and focuses on the main features of its retirement pension and unemployment insurance programs. Section B also describes experiments for reforming the retirement pension system. Section C provides a brief conclusion to the chapter. A. The Rationale for Social Security Reform in the Context of China's Economic Reforms 1.5 Social security reform is an essential component of China's economic reform. The traditional labor insurance system for state and collective enterprises strongly ties workers to their enterprises for nearly all their living needs throughout their lifetime. Under the traditional system, so much of a worker's life depends on his "danweia that it is politically impossible to let enterprises go out of business no matter how unprofitable they are. Enterprise bankruptcies have been very few. Nonetheless, enterprises facing the threat of bankruptcy are pressured to improve efficiency. The long-term efficiency gains outweigh the problems posed by the few bankruptcies that actually take place in the short term. If the problem of providing labor insurance to workers affected by the albeit infrequent event of bankruptcy is not addressed through social security reform, enterprise and price reform might otherwise be stalled. The establishment of an unemployment insurance program in 1986 by the government was designed to facilitate enterprise reform by reducing resistance to the threat of enterprise bankruptcy. Enterprise Reform 1.6 The Twelfth Central Committee of the Chinese Communist Party of October 1984 identified the 'task of invigorating enterprises as the key to reforming the national economy." Enterprise reform is designed to make enter- prises responsible for profits and losses in order to increase incentives for efficiency. Reforms have been introduced in prices, finances, taxes, wages and employment with the overall objective of making enterprises face economic prices for resources and uniform regulations and, as a consequence, compete efficiently for resources. 1.7 China's current social security sy;tem presents a major obstacle to making enterprises behave more efficiently in a market oriented economy. The  - 3 - traditional labor insurance program initiated in 1951 was designed for state enterprises and government agencies. This system makes enterprises bear sole responsibility for their workers' retirement pensions and other social insur- ance benefits. A consequence is that enterprises face dramatically different pension costs--older enterprises have larger numbers of retirees to support. In the past, the decentralized financing of social security was of little more than nominal significance because enterprise budgets were not separate from the government budget. Enterprise reform is intended to separate enterprise and government budgets which converts nominal financial obligations into real obligations. The basic dilemma of enterprise reform is the follewing: strict adherence to financial autonomy jeopardizes enterprise financing of labor insurance, which in principle is meant to be independent of the enterprise where a worker is employed; conversely, efforts to maintain the coverage of labor insurance through grants from the government budget seriously compro- mises the main objective of enterprise reform.3/ The uneven burden of retire- ment pensions is a major problem facing enterprises. The labor insurance system has to take into account the consequences of the risk that some enter- prises may be insolvent, perhaps because of uneven pension burdens. Sharing responsibility for providing retirement pensions and other social insurance benefits evenly among enterprises--for example, based on number of active workers rather than retired workers--must accompany the process of enterprise reform. Employment Policy 1.8 Since 1979 China has implemented the policy of 'combining three employment channels' which represents a move from employment in state enter- prises, the traditional first channel of employment, to the encouragement of employment through formation of collective enturprises or individual busi- nesses. Local labor bureaus were introduced to replace the centralized system for finding employment for urban job seekers.4/ A 1982 government initiative encouraged employment of workers for a fixed term in some state enterprises, in contrast with standard lifetime employment.5/ In 1983 after elimination of the "ding ti" system (the option available to an adult child to replace a parent leaving a job because of retirement, prolonged illness, or death), many enterprises signed on contract workers and by the end of 1985 the total jumped to 3.15 million.6/ The 1986 labor regulations ended the guarantee of lifetime employment for new workers resulting in state and collective enterprises' 3/ See Hussain, Athar, Hong Liu and Xiachong Liu. 'Compendium of Literature on the Chinese Social Security System", ;989, p. 22. 4/ See Yue, Guangzhao. "Employment, Wages and Social Security in China". International Labor Review, Volume 124, No. 4, July-August 1985, pp. 414-415. 5/ See Liu, Lillian. "Recent Social Security Developoments in the People's Republic of China". Social Security Bulletin, Volume 50, No. 4, April 1987, p. 77 6/ See Davis, Deborah. 'Unequal Chances, Unequal Outcomes: Pension Reform and Urban Inequality". The China Quarterly, June 1988, p. 236.  - 4 - employing new workers on fixed-term contracts.7/ The labor contract system was not fully enforced in the years immediately following the 1986 regula- tions. Nonetheless contract workers hired after 1986 represent 75 to 802 of new recruits for whom the labor contract system is intended.8/ The total number of contract workers has grown rapidly to 12.43 million by the end of 1988. All workers hired by enterprises are supposed to be contract workers. 1.9 Employment reform in conjunction with enterprise reform threatened to undermine social stability as these reforms challenged the social security of workers and salaried employees amid fears of inflation. The traditional com- mand economy may have been nonproductive and inefficient in many ways, but at least it offered job security, albeit at the cost of shortages and consumer dissatisfaction.9/ The recently established unemployment insurance program is designed to reduce resistance to the replacement of lifelong employment with contract employment.10/ 1.10 An important objective of the government's employment policy is to make labor more mobile, at least among enterprises in a locality, to meet the needs of a changing economy. However, gaps and differences in social security coverage create barriers to labor mobility. Workers will not willingly leave a job covered by the labor insurance program if their benefits are reduced or lost altogether. Nor will they move freely if benefits differ across enter- prises. Introduction of social security reforms that maintain workers' cover- age and benefits from job to job would facilitate labor mobility. 1.11 Wage reform, as a complement to employment policy, is intended to implement the principle of "to each according to his work" and avoid counter- productive egalitarianism and favoritism by linking workers' incomes closely to enterprises' economic performance and individuals' contributions to produc- tion. Wage reform is extremely difficult when workers' social insurance cov- erage and benefits vary. Even within enterprises, workers' benefits can vary depending on whether they are permanent, contract, or temporary. Incentives for greater effort implied by linking wages to production can be easily out- weighed by inadequate social insurance coverage. 1.12 An important reform issue is the transition for current workers from coverage under the traditional program of strict employer liability for social security to a new program based on contributions, either from the employer, workers, or both. Perhaps contributions from new workers can help pay for obligations to older workers and give the state some breathing space for accumulating revenues for future retirees. The difficult 'knot' for China to disentangle is that an elaborate insurance system has been in existence for 7/ See Chapter III for further discussion of these regulations. 8/ The permanent labor system still applies in the government sector which accounts for about one-third of employment. 9/ See Yahuda, Michael. 'China', Asia and Pacific Review, 1988, p. 63. 10/ As well as to the threat of enterprise bankruptcy as mentioned above.  - 5 - urban workers and anything less favorable would arouse resistance from perma- nent workers.ll/ 1.13 Extension of coverage may bring in predominently younger workers and thus provide a source of net revenue for those retiring in the currently cov- ered sector. The country may be able to structure a pension system that pro- vides adequate benefits to current retirees while accumulating reserves to Increase the capital stock and workers' real wages. Tax and Price Reform 1.14 The basic objective of tax reform is to move from full remittance of each enterprise's profit to the state to uniform taxation of similar enter- prises at a level permitting autonomous decision-making on rroduction, invest- ment, and employment. As a result, enterprises would face the same incentives for profit-making and investment--the so-called "level playing field' from a tax perspective. Government would have an indirect lever for providing incen- tives uniformly across all enterprises and achieving macroeconomic balance.121 1.15 Tax reform is an important element of China's economic reform program for decentralizing decision-making on production and investment, letting the market influence decisions, and improving microeconomic efficiency. However, when faced with the need to preserve workers' labor insurance benefits, espe- cially pensions of retired workers, the government is pressured to shift from indirect levers such as uniform taxation to a more direct role. Uniform taxa- tion is often sacrificed to entice enterprises to participate in retirement pension pools. For example, in Shanghai, enterprises making net contributions to the pension pool, that is those whose contributions exceed their reimburse- ment from the pool for their pension costs, have their adjustment tax reduced to compensate for their net contribution. Enterprises receiving a net dis- bursement have their adjustment tax increased by an equivalent amount. Thus enterprise taxation is altered to reestablish the uneven burden of retirement costs before pooling. The tax deduction of uneven retirement costs distorts the calculation of taxable income. The majority of retirement expenditures comes from reduction in the tax base. Uniform taxation across enterprises can only be achieved if it is accompanied by uniform pension provision, a funda- mental principle of social security reform. 1.16 The fundamental objective of price reform is to establish prices in line with the utruer scarcity value of resources so that the allocation of resources for production, consumption, and investment is efficient. However, it is difficult to remove controlled prices that subsidize enterprises strapped with disproportionate pension costs. At some point, only the lifting of full financial responsibility for pensions from enterprises favored by controlled prices or explicit subsidies will allow price reform to go forward. In this manner, social security reform can facilitate price reform. 111 See Chow, Nelson V.S. The Administration and Financing of Social Security in China. Centre of Asian Studies, University of Hong Kong, 1988, pp. 71-72. 12/ The government would also have other levers, such as restructuring and bankruptcy, that could be applied on economic grounds.  - 6 - B. Overview of Social Security and Introduction to Retirement Pension System and Unemployment Insurance Program 1.17 China's social security system encompasses a variety of programs and benefits in three main categories: (1) social relief; (2) social welfare; and (3) labor insurance. 1.18 Social relief refers to a variety of interventions by the state to assist individuals who have no means of support or who have been affected by natural disasters. Disaster relief is especially important because approxi- mately 70Z of the population lives in rural areas and over 60Z of the rural work force is employed in agriculture where floods, fires, and other natural disasters can be devastating to people's livelihood. Every year about 50 million people on average receive such assistance.13/ The Ministry of Civil Affairs (MOCA) is responsible for providing social relief. 1.19 Social welfare comprises a wide range of assistance which includes hardship allowances and social facilities, such as kindergartens, educational facilities, and other institutions for orphans, the mentally ill and handi- capped individuals in urban and rural areas. Social welfare programs and facilities are administered by MOCA. Box 1.1 provides some details on MOCA's social welfare activities. The small scale of these activities indicates that China's rural inhabitants turn mostly to their families for help and get out- side assistance only in exceptional circumstances. Box 1.1: SOCIAL WELFARE IN CHINA In urban areas the Ministry of Civil Affairs (MOCA) provide support to *hardship households through a social welfare network consisting of 8,000 district offices and, extend- Ing from these oftIces, 60,000 neighborhood committees. In 1985 about 7 milion households were assisted and 4 million were lifted out of poverty.lX Rather than just provide material assistance, MOCA tries to enhance the productive capabiTity of Individuals by Ongg I ngthem in economic activities. MOCA has organized various factories and enterprises to prov d Job oppo-tunitles for the disabled. In 1988 there were 84,000 of these so-called welfare enter- proies having an output value of Y 18.1 billion and mploying 1.81 million Individuals, of whom 5s0,000 are disabled. Local governmsnt revenue financos assistance to poor households through noighborhood co_mittee. The most visible program of social welfare In rural areas Is the Five Guarantees (Wu Lao) system which provides food, shelter, clothing, medical care, *nd burial for indigent eIderly Individuals without family or other means of support, and other hardship cases, for xample the disabled and orphans. In 1986 over 8 million people, about SOX of whom were elderly, were helped under this system and, out of this number, 876,000 were taken care of In homes for the elderly financed by townships and villagos .V 13 Chow, Nelson W.S., The Administration and Financing of Soclal Security In China. Centre of Asian Studies, UnIvereity of Hong Kong, 1988, Chapter 4. V, Chow, OD. cit. 1.20 Labor insurance, as defined by the 1951 Labor Insurance Regulations, is provided to workers and staff in state enterprises and big collectives. A separate set of regulations established labor insurance benefits for employees 13/ People's Daily, overseas edition, Hay 2, 1988.  - 7- Gf government, the Chinese Communict Party, and nonprofit incttitutions. (Small collective enterprises, those operating under authority below the pre- fenture or couvty level, have their own labor insurance benefits based on what they can afford.14/) Labor insurance benefits in the above enterprises and institutions fall into two broad categories: (1) labor insurance as it is conventionally understood internationally, which includes retirement pensions, medical benefits for active a d retired workers and their dependents, cash benefits for sickness and maternity, work injury and disability benefits, and survivor benefits; and (2) employee welfare benefits which refer to various cash and in-kind benefits, such as subsidies for commuting and recreation, for maintaining workers' standard of living. The 1986 labor market reform regula- tions added unemployment insurance to China's labor insurance system. 1.21 The State Council is the supreme policy-making body for labor insur- ance, including retirement pensions and unemployment insurance. It reviews and deliberates on recommendations from the Ministry of Labor (MOL) and other central ministries, and it issues executive regulations delineating program eligibility and benefits to be carried out nationwide. 1.22 In China, national-level government agencies, such as MOL, are responsible for policy development and the drafting of basic social security regulations. MOL, for example, only issues "operational guidance" to provin- cial and local labor bureaus--transmitting and interpreting national policy guidelines but leaving implementation details to these bureaus and the enter- prises themselves. In provinces and cities, a complete set of bureaus dupli- cate national ministries. They are not the administrative arms of central ministries, but rather direct subordinate bodies of the provincial, city, or county government. These local government agencies establish implementing procedures for individual enterprises to carry out, often with modifications in the original design to make the program more compatible with local condi- tions. The enterprise generally administers the programs with limited super- vision from local bureaus of labor at the provincial, municipal, and county levels. An alternative is for the program to be administered through the office of labor remuneration of a functional government agency to which the state enterprise belongs (for example, the Wuhan Bureau of Labor supervises local textile factories through the office of labor remuneration under the Wuhan Light Industry Bureau). This office may further introduce practices to sutit its own purposes. 1.23 HOL is the ministerial agency with formal policy development and guidance responsibility regarding labor insurance programs.15/ The section 14/ Chinese Academy of Social Sciences, "Social Welfare" in Information China, Vol. 2, Pergamon Press, 1988. p. 808. 15/ MOL was reinstated after the Cultural Revolution as the State Bureau of Labor. It assumed the status of a ministerial agency in 1982 as the Ministry of Labor and Personnel. In 1988, however, this ministry was divided into Ministry of Labor and Ministry of Personnel. The latter was created to assume the responsibility of employment and social insurance issues concerning civil servants, namely, cadres and workers employed by government and party organizations and by cultural, educational and scientific institutions. See also Chart 1.1.  within MOL that is devoted solely to labor insurance issues is the Department of Labor Insurance and Welfare. Historically, its principal objective in labor insurance matters is to protect the welfare of its clientele, that is, workers and cadres in state enterprises and their dependents. The bulk of MOL's activities focus on issues of employment, occupational safety, atnd wages and salaries (see Chart 1.1 at the end of this chapter). 1.24 In recent years, MOL has encountered challenges to its erstwhile exclusive policy authority in social security matters from other central gov- ernment agencies. Issues such as the uneven burden of retirement expenditures among enterprises, the rapidly increasing costs of social security in an aging society, the constraints on labor mobility caused by enterprise-administered labor insurance programs, the need to coordinate the implementation of bank- ruptcy law with unemployment insurance, and other issues have prompted MOL and other agencies, such as the Ministry of Finance (MOF), System Reform Commis- sion (SRC), and People's Insurance Company of China (PICC), to review existing labor insurance programs. 1.25 Additional details on programs in the three categories of China's social security system, including the agencies responsible for policy and administration and sources of financing, are presented in Table 1.1 at the end of this chapter. The focus of this report is on retirement pensions and unem- ployment insurance in the urban formal sector, two major components of labor insurance that are critically related to urban economic reforms. The Retirement Pension System 1.26 China's retirement insurance system has two components: (1) a tradi- tional system based on individual enterprise provision of labor insurance benefits, including retirement pensions, according to the 1951 labor insurance regulations; and (2) a reformed system in which finances are pooled among enterprises in a locality to provide retirement pensions. An important fea- ture of China's system is that these two components exist side-by-side in almost all cities and counties. Some enterprises participate in retirement pension pooling while others do not for various reasons discussed in Chapter II. These latter enterprises operate under the traditional system. 1.27 Traditional System. The traditional retirement pension system is governed by two regulations issued in 1978 by the State Council. One is "State Council's Provisional Regulations on Settlement of Old and Sick Cadres,' which sets guidelines for benefit programs of government officials above the rank of a deputy county director who retire due to old age or health reasons. The other is 'State Council's Provisional Regulations on Retirement of Enterprise Workers.' This applies to staff and workers in state enter- prises, nonprofit organizations, as well as government offices. Big collec- tives are encouraged to follow the same labor insurance regulations applying to state enterprises. About two-thirds of collectives provide such coverage but usually with reduced benefits. 1.28 Below the State Council are various agencies in charge of retirement pension policy enforcement and program implementation. MOL sets and helps enforce guidelines for state enterprise staff and workers. The Ministry of  Personnel (MOP) is in charge of the same tasks for officials and employees in government and nonprofit agencies. In addition to these two ministries, MOCA manages pension programs, through state budget allocations, for those aged people without family support in rural areas and for the retired soldiers. For the latter category, the Central Military Commission is responsible for determining the benefit levels and entitlement criteria. 1.29 One crucial task performed by a local labor bureau is to review and certify what package of benefits a potential retiree is eligible for. It does so by going over the documents regarding age, length of services and types of work. The documents, however, are prepared by the enterprises themselves and labor bureaus give approvals so long as the documents are consistent and do not have any irregularities. In cases where there appears to be a problem with the documents, labor bureaus ask to see the original files kept at enter- prises. Benefit payments are made by the enterprises. 1.30 Under this system, the role of the agency in charge of the enterprise --for example, the textile bureau in charge of a shirt factory--becomes very important in policy enforcement. First, the labor bureau has to work through the responsible agency to correct any irregularities in policy enforcement, which, in reality, means that many irregularities are not corrected. Sec- ondly, it is the duty of the responsible agency to subsidize the general losses incurred by its enterprises. These general losses may arise due to a number of factors: inefficient management, a bureaucratic decision to produce a product whose price happens to be low, and heavy pension burdens. There is no specific fund to subsidize losses from pension burder.s. 1.31 Reformed System. The traditional system does not necessarily govern retirement pension practices in China. Since the mid-1980s MOL has been pro- moting resource pooling for permanent workers' retirement pensions to ease the uneven burden of retirement expenditures on enterprises that are now responsi- ble for their own profits and losses. It also introduced a new retirement pension program for contract workers. Since 1986, reforms have been conducted in about 802 of all cities and counties, about 2,000 in number, vhich have achieved varying degrees of pension pooling within regions.16/ What mainly distinguishes the traditional system from the reformed system is the unit of pension provision. Under the traditional system, the basic unit of pension provision is an individual's workplace--an enterprise or government department --whereas under the reformed system the basic unit is a collection of enter- prises organized either along administrative--city and county governments--or sectoral lines. This difference implies pensions are financed under the tra- ditional system out of the income or budget of employees' workplaces and under the reformed system by pooling funds among workplaces. 1.32 Retirement pensions for government staff and workers are not part of the reformed pension system. Their retirement pensions are provided under the 16/ In Wuhan only 452 of state enterprises and 392 of collective enterprises participate in separate pension pools for each type of enterprise. In Qingdao 982 of state and collective enterprises above the county level participate in a single pension pool. See Chapter II for additional details.  - 10 - traditional system, that is as specified in the 1978 regulations, and financed as part of the budget for their respective government agencies. 1.33 MOL sets the general guidelines for experiments in retirement pension pooling among state enterprises. Local governments implement these guidelines in consideration of lo:al conditions. MOL, for example, mainly determines the following strategic issues: (a) the principle that "expenditure should determine the level of revenue and there should be a small surplus' in pooling funds for pension purposes; (b) that the basic unit of pension financing and provision should start with cities and counties and gradually move up on the administrative ladder; and (c) that the pooled funds should go toward workers' pension, noinstaple food and other allowance requirements, but not medical expenses. 1.34 Financing the rapidly escalating costs of labor insurance programs and their role in reducing central government tax revenues are very much a concern for MOP. Formally, MOF has the authority to determine contribution rates and the size of administrative budgets for managing the reserves but in reality the issues are decided by the local governments and their subordinate labor bureaus. As a result, there are many different contribution rates across regions, sectors and even across enterprises in the same sector. 1.35 Pooling of funds can be done either on a regional or a sectoral basis. All the experiments under the MOL system are on a regional basis, although within the same region, there can be different contribution rates across different sectors or even among different enterprises in the same region. 1.36 Most of the pension pooling schemes are done at the level of cities and counties with the following exceptions: Fujian is pooling at a provincial level and Beijing, Shanghai and Tianjin--three municipalities directly under the central government and with decision-making powers equal to a province-- are themselves basic units of pension financing and provision. Currently, retirement pension funds pooled from enterprises under the MOL system are managed by labor insurance companies that are directly subordinate to MOL's regional bureaus. The finance departments of those agencies that pool funds on a sectoral basis appear to manage the resultant reserves. The intention on the part of MOL is to expand the scope of pension financing from enterprises to cities and counties and ultimately to the national level. 1.37 The Ministries of Railways, Post, and Telecommunications, the elec- tricity department of the Ministry of Energy and the National Construction Company pool funds on a nationwide but sectoral basis. MOL issues "opera- tional guidance" but is not involved in their work. Specific practices such as contribution base and rates differ among these agencies. The reasons that these sectors are singled out is due to the economic features of their opera- tions--that they operate across different regions and administrative zones.  - 11 - 1.38 Labor market reforms have an important bearing on the reformed retirement pension system. An objective of pension pooling is to extend pen- sion coverage to new categories of workers, specifically contract workers. As a result of the 1986 regulations establishing the labor contract system there is now a clear distinction between individuals with permanent jobs and indi- viduals hired under the labor contract system. Individuals with permanent jobs may be either staff, such as managers, officials, teachers, medical per- sonnel, or workers hired before 1986. Permanent staff and workers are collec- tively referred to as permanent "employees". The permanent employment system still operates in the government sector. As mentioned they have their own pension program under the traditional retirement pension system and financed by the state budget. 1.39 Under the reformed retirement pension system pension pools were set up separately for permanent employees and contract workers in enterprises in most regions.17/ Some regions even have separate pooling for state and collective enterprises.181 The pension pools for permanent employees are funded on a pay-as-you-go basis. Enterprises contribute a percentage of a portion of their permanent employees' total wages to the pension pool. Perma- nent employees themselves do not make an individual contribution from their wages. The enterprise contribution rate is determined by each locality so as to match contributions with permanent employees' retirement expenditures. 1.40 Two sources of funds cover contract workers' retirement pensions. One comes from enterprises' pretax earnings at 15? of the total wage bill of contract workers. The other comes from deductions of contract workers' pay at no more than 32. The two sources then form a part of a pension fund to be administered by MOL's labor insurance companies. Both contributions are man- datory. Contract workers are eligible for these benefits after paying contri- butions for 15 years. Pension pooling for contract workers is described as a funded program because contributions are deposited in a bank account and, because contract workers are too young to be retired, are being held for future payment of retirement pensions.19/ 1.41 In addition to MOL, SRC, the agency with responsibility for promoting China's overall economic system reforms, has been investigating the feasibil- ity of revising the retirement pension program, setting up a new administra- tive infrastructure to apply labor insurance programs across enterprises regardless of the form of ownership, and other issues. SRC is designing a scheme for Shenzhen whereby individuals are legally required to contribute 17/ Shanghai is a notable exception having a single pension pool for both permanent employees and contract workers. Shanghai was compelled to do this as a way to reduce the contribution rate given its aging population. This is discussed in Chapter II. 18/ Wuhan, for example, which is described in Chapter II. 19/ The level of funding is not clear because the relationship between the amount of reserves and the benefits for which reserves are accumulating is not specified. See Box 4.2 in Chapter IV for specific definitions of alternative funding levels.  - 12 - toward part of their retirement and medical insurance. The individual's con- tribution rate is not known. Some experiments are also being conducted in ten counties in coastal regions where per capita income exceeds Y 700. Individual contributions in these experiments, however, are voluntary. MOCA is to devise regulations and PICC is to implement the schemes. 1.42 Jurisdictional conflicts between MOL and PICC surfaced in 1984 when the State Council decided that PICC be responsible for developing plans for social insurance of employees in urban collective enterprises, thus limiting MOL's sphere of influence to only the state sector. However, four years later in June 1988, it approved a proposal for MOL to serve as the administrative agency for social insurance programs of all enterprises and also institutions that have introduced independent accounting (zifu yinkui de shiye). In Decem- ber 1988, however, the State Council was reviewing a proposal submitted by PTCC to seek authority for managing retirement insurance programs in all enterprises. 1.43 In late 1987, in an effort to coordinate different ministerial and academic reviews of social security issues, the State Council set up a social security working group consisting of representatives from MOL, MOF, SRC, PICC, and research institutes affiliated with the Chinese Academy of Social Sciences (CASS) and local universities to discuss reform proposals in social security.20/ The Unemployment Insurance Program 1.44 In July 1986 the central government issued three regulations as an integrated package for reforming China's labor market. The regulations regarding 'The Implementation of Labor Contract System by State-Owned Enter- prises' ended new permanent employment and established the labor contract system, which had previously been introduced in selected regions, nationwide. According to this regulation, all new recruits to state enterprises could only, from October 1, 1986, be employed under contract for a specific period of time, usually one to five years, without guarantee of reemployment. This contract includes a probation period of three to six months, during which it may be terminated by the enterprise. This ability to hire and dismiss workers accorded to enterprises was enhanced by the regulation concerning "The Dismis- sal of Discipline-Violating Workers by State-Owned Enterprises.* With effect 20! Ministry of Civil Affairs (MOCA), State Planning Commission (SPC), China National Committee on Aging (CNCA), and All-China Federation of Trade Unions (ACFTU) have also engaged in research and proposal drafting in social security matters. CNCA was first organized by the State Bureau of Labor (precursor of MOL) in 1981 to take part in the World Assembly on Aging, and was subsequently established in 1982 at the ministerial level in response to a request from the United Nations. Its membership includes government agencies, media groups and community organizations (that is, local committees of retired workers). ACFTU has shown concern over retirement insurance programs as an advocacy group on behalf of retired workers whose benefit payments may be in jeopardy in enterprises overburdened with retirement expenditures, and whose retirement income suffered erosion in real value since 1984 as result of inflation.  - 13 - from October 1986, workers can be dismissed for various offenses including poor work attitude, violation of operating procedures, and willful trouble- making. The regulations for "State-Owned Enterprise Workers' Wait-for- Employment Insurance* completed the package of labor market reforms by estab- lishing an unemployment insurance program as a natural complement to the labor contract system. This program was introduced to reduce friction between work- ers and enterprises regarding the implementation of the labor contract system by providing benefits to workers whose contracts are not renewed or termi- nated. 1.45 Since 1986 the regulations on unemployment benefits have been put into effect. Four categories of unemployed workers are eligible for unemploy- ment benefits. They are: (1) workers of enterprises that declared bank- ruptcy; (2) workers fired on the verge of enterprise bankruptcy; (3) workers whose contracts are not renewed by enterprises: and (4) workers fired by the enterprises. Benefit levels are calculated as a percentage of the average monthly standard wage received in the two years prior to the job termination and are determined by the following criteria: Criteria (a) 5 or more years of service No more than 24 months of benefit pay- ments, of which 60 to 752 of standard wage is paid in the first 12 months and 5O0 is paid in the second 12 months. (b) Less than 5 years of service No more than 12 months of benefit pay- ments with each monthly payment equal to 60 to 70? of standard wage. 1.46 Enterprises are to contribute 1? of their standard wage bill to form an unemployment fund, which is administered by the MOL's labor service compa- nies. These companies are in charge of recordkeeping, benefit payments, facilitating job search and providing training. Unemployment benefit funds are managed by labor service companies directly under MOL's regional bureaus. The basic units of financing and provision of unemployment benefits are the provinces. C. Conclusion 1.47 Under the traditional retirement pension system, enterprises face dramatically different costs because each bears financial responsibility for its workers' benefits. Enterprise-based financing not only distributes cost unevenly but also impairs the phasing out of inefficient enteprises. Govern- ment support is elicited for enterprises whose retired workers' pensions would otherwise be in jeopardy. The government is often compelled to maintain con- trolled prices or negotiate lower taxes to subsidize these enterprises. This hinders enterprise, price, and tax reform. 1.48 A key objective of social security reform is to relieve enterprises of full responsibility for their workers' retirement pensions by establishing funds that pool resources and risks among enterprises. By doing so, social  - 14 - security reform would complement and support other economic reforms. Retire- ment pension pooling would reduce the financial burdens of old enterprises and allow phasing out of obsolete and inefficient ones without jeopardizing their workers' well-being. Introduction of a plan that maintained workers' coverage from job to job would facilitate labor mobility. The uniformity of pension costs for enterprises, at least within a given region or sector, would facili- tate the establishment of uniform taxation and prices that reflect true eco- nomic cost. An important operational task is to determine the appropriate regional and sectoral coverage of these pools. 1.49 Economic reform in China has reached a point where social security reform is an important step--a step needed to facilitate labor mobility in a changing economy, support progress of China's economic reforms, and promote national economic development and growth.  ER 021 Table l ./C&$A-ER/P. llchio/aO-AUI-89/mjd/mJd Table 1.1: SOCIAL SECURITY SYSTEM IN CHINA /1 Sector/pr.grm PolIcy B Adoinltrotion Financiag I. EMILOYER-PROVIOED LAR D RA_ CE AND WELFARE uwzvS E A. STATE EiNER RRSE MOL , (Co.vrs-:. Cmplsory) - Permanent Worker Retirement Insurance Enterprise, Local Enterprios Busimu e Expense: Contributlons to Labor Insurance locnl pension pool (include state tax expendi- Agency ture due to deductibility from taxable income oS); Govt. subsidies when necessary - Contract Worker Retiromnt Insurance Same as above Enterprise Businme Expense: 1C of contract workers' standard wag*, allowancne and subsi- dies to local pension pool (includes state tax expenditure due to deductibility from taxable income /o); Individual contribution of 35 of standard7ial; Govt. subsidies when necessary - Unmploy.snt Insurpnce Enterpriso Local Enterprise Busines Expense: Unemployment Labor Service Insurance Tax of 15 of standard wage, al i ow- Agncy ones and s*abldies (Includes state tax *xpen- diture due to deductibility from txablo lncom LJ); Local Govt. subsidies when necessary - Otber Labor Insurance (medical care, cash Enterprise Enterprise Business Expense (IIX of standard beeTfts for sicknes and m*ternity, surviv- wages, allowance And subsidies, deductible from ore bnefitt, work Injury benefits) taxable income); Govt. *ubidies when necessary - Employee Welfare sonetita ai Enterprise Sme as *abovo plus additional contribution from after-tx inco If necessary S. COLLECTIVE ENTERPRISE MOL (Covorage;l: Voluntary, two thirds) - Permnent Workor Retiremet Insurance Enterprioe, Local Enterprise Businme Expense: Contributions for Labor Insurance retiremet Insurance (includes state tax *xpen- AenKcy or PICC diture due to deductibility from taxablo Local Branch Incaom L